Over recent years, major private equity developments have changed how LPs and GPs perform. How these main stakeholders interact ensures investment ventures succeed and directly influences how private equity funds perform.
It is important for investment fund participants in private equity, venture capital or any other collective scheme to know the differences between Limited Partners and General Partners. One partner has certain functions and liabilities, while the other has specific responsibilities and roles in a company’s fund.
Learning about GP vs LP is necessary to understand the functioning of private equity.
What General Partners (GPs) Do?
General Partners’ role is to oversee the day-to-day management of the private equity fund structure. Usually, they consist of finance professionals and investment strategy experts as managing entities. GP discovers investment opportunities, conducts basic research, chooses investment options, manages matters after investing, and finalizes exits to make the investments profitable.
GPs are bound to act in a way that is best for the fund and its investors. They are usually responsible for handling the fund’s day-to-day operations, even though they usually invest a very small portion of its assets. The main sources of compensation for a PI are an annual management fee (1.5% to 2%) and a 20% cut of the profits over a fixed threshold.
What Defines a Limited Partner (LP)?
Limited Partners invest the most money into private equity funds. Some examples are pension funds, insurance companies, endowments, family offices, sovereign wealth funds and accredited individuals. Unlike general partners, limited partners focus only on advising and do not get involved in the work of daily operations. They trust GPs to carry out their plans and profit from their investments.
LPs provide the fund with money upfront, which is spent over time as investments are completed. According to the terms of the limited partnership, the profits after the GPs’ carried interest are distributed equally to the partners. Being a limited partner, you are only liable for the investment provided and not responsible for the fund’s liabilities, unlike GPs.
Difference between being a Limited Partner and General Partner
In General and Limited Partnerships, there is a major difference in roles and rights, especially when leading the business, making decisions and dividing profits.
Decision-Making Authority
The General Partners make all the important decisions. Venture capitalists are responsible for selecting where to put the company’s funds, how much to invest in each area and when to exit investments.
LPs do not take part in deciding about individual investments or the company’s direction. Yet, the LPA for a limited partnership gives investors control by highlighting how it is organized, its rules for investing, fees and manages the fund. An LP advisory committee, known as the LPAC, discusses issues such as conflicts, valuations and certain aspects of governance, but the group does not have decision-making power.
Exposure to Risk and Liability
Risks also play a major role in creating differences among countries. GPs are required to pay for all responsibilities and decisions made by the partnership. If the fund encounters financial debts or lawsuits that are too high for its assets, GPs are liable. This emphasizes the need for directors to manage their actions and duties with great care.
Similarly, LPs benefit from being limited liability businesses. Their investment exposure is limited by the amount they committed. As a result, LPs have less risk in terms of legal and financial issues, but they are affected by the ups and downs of the fund’s investments.
Compensation Structure
GPs collect money mainly through charges called management fees and carry interest. Usually, by committed capital, the fee of 1.5% to 2.5% is used to fund the routine operating charges of the fund. If the returns are higher than a preset target rate, for example, 8%, the GPs will receive 20% of those profits as incentives for their success.
After the GP deducts the fees and carries interest, LPs regain their share of the profits. Usually, their income is derived passively through the growth, payouts or interest earned by the companies in their portfolio. Being uninvolved in daily activities, LPs depend on the success of the GPs for their profits.
Responsibilities Involving Laws and Regulations
By law, GPs are the representatives of the fund. They enter into agreements, oversee their portfolio companies and guarantee adherence to financial rules. GPs must update LPs on the performance and health of the fund.
LPs have no power to manage the fund and don’t need to oversee strict compliance with regulations. Still, the GP must be honest and share information frequently to remain updated.
Exit and Returns
GPs plan and guide the selling of companies so their investors get the best possible profits. They decide when and how to sell the assets based on the market and the method set by the fund’s strategy.
At this stage, LPs get the financial proceeds resulting from the exit. GPs count on their skills to select the ideal time for selling and maximize the multiple on invested capital (MOIC) and the internal rate of return (IRR).
Conclusion
The main element that supports private equity is the relationship between General Partners and Limited Partners. GPs have skills in finance, how to run a business and responsibility. These investors invest their money and rely on professionals for good returns. All these roles enhance each other.
Although the GP is at greater risk, the LP is responsible for providing the money the fund needs. Anyone working in private equity must know this issue. It explains why considering both sides is vital when choosing the other. Both parties can benefit greatly from the relationship when the terms are clear.
